August 30, 2012

In 2008, U.S. regulators banned the short-selling of financial stocks, fearing that the practice was helping to drive the steep drop in stock prices during the crisis. However, a new look at the effects of such restrictions challenges the notion that short sales exacerbate market downturns in this way. The 2008 ban on short sales failed to slow the decline in the price of financial stocks; in fact, prices fell markedly over the two weeks in which the ban was in effect and stabilized once it was lifted. Similarly, following the downgrade of the U.S. sovereign credit rating in 2011—another notable period of market stress—stocks subject to short-selling restrictions performed worse than stocks free of such restraints.…Our analysis of the empirical evidence from the United States suggests that the bans had little impact on stock prices. Even with the bans in place, prices continued to fall. At the same time, the bans lowered market liquidity and increased trading costs. On the latter point, we estimate that the ban raised total trading costs in the U.S. equities options market by $500 million in the period between September 18 and October 8, 2008.…The equity markets provide telling evidence of the costs imposed by short-sale bans. In their multivariate analysis, Boehmer, Jones, and Zhang (2009) find that the 2008 short-sale ban in the United States was associated with a 32 basis point increase, on average, in relative effective bid-ask spreads for the banned stocks. For the 404 financial stocks that were subject to the ban for its duration—September 18 through October 8, 2008—the increase in spreads represents an increase in liquidity costs of more than $600 million.

All of which suggests that short-sellers are far from being enemies of normal market activity – and banning their activities is unlikely to turn bear markets into bull markets, or even provide much-needed stability when stocks are falling .

One commenter on the Globe piece writes:

There were more sellers than buyers then, so obviously stocks went down. Short sellers would have made it even worse. How dumb does one have to be to miss that obvious fact

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Quite right, short sellers will indeed increase the speed of loss … until the market reaches it clearing price. Short sellers assist the market to reach the clearing price faster.

Sorry this is so late, folks! But better late than never!

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